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Mortgage lenders are chiefly interested in your ability to repay the mortgage. They need to determine if you qualify for a loan, so, they will consider your credit history, your monthly gross income and how much cash you’ll be able to accumulate for a down payment. You need to understand a concept called “debt-to-income ratios” and you will know how much house you can afford.

Debt-to-income coefficient

The standard debt-to-income ratios are the expense of housing, or front-end, ratio; and the total debt-to-income, or back-end, ratio.

Front-end ratio: The housing expense, or front-end, ratio shows how much of your gross (pretax) income for the month would go toward the mortgage payment. As a general advice, your monthly mortgage payment, including principal, interest, real estate taxes and homeowners insurance, should be less than 28 percent of your gross monthly income. You can calculate your housing expense ratio, multiply your annual salary by 0.28, and then divide by 12 (months). The result is your maximum housing expense ratio.

Front-end ratio

Maximum housing expense ratio should be equal to annual salary x 0.28 / 12 (months)

Back-end ratio: If you want to see how much of your gross income would go toward all of your debt obligations, including mortgage, car loans, child support and alimony, credit card bills, student loans and condominium fees — the total debt-to-income, or back-end, ratio will show you that. Altogether, your total monthly debt obligation should not exceed 36 percent of your gross income. If you want to calculate your debt-to-income ratio, multiply your annual salary by 0.36, then divide by 12 (months). The answer will show your maximum allowable debt-to-income ratio.

Back-end ratio

Maximum allowable debt-to-income ratio is equal to annual salary x 0.36 / 12 (months)

Example
Imagine a homebuyer who makes $40,000 a year. His maximum amount for monthly mortgage-related payments at 28 percent of gross income is $933. ($40,000 times 0.28 equals $11,200, and $11,200 divided by 12 months equals $933.33.)

Furthermore, the lender says the total debt payments each month should not exceed 36 percent, which comes to $1,200. ($40,000 times 0.36 equals $14,400, and $14,400 divided by 12 months equals $1,200.)
Example

The next diagram shows your maximum monthly payment and maximum allowable debt load based on your gross annual income (remember, gross income is pretax income):

Gross income———- 28% of monthly———– 36% of monthly
$20,000——————— $467————————— $600
$30,000 ———————$700————————— $900
$40,000———————-$933————————— $1,200
$50,000 ———————$1,167————————- $1,500
$60,000 ———————$1,400————————-$1,800
$80,000———————-$1,867————————-$2,400
$100,000——————–$2,333————————-$3,000
$150,000——————–$3,500————————-$4,500

Typical debt ratio requirements by loan type:

• Conventional loans:
Housing costs are 26 percent to 28 percent of gross income for month.
Housing plus debt costs are 33 percent to 36 percent of monthly gross income.

• FHA loans:
Housing costs are 29 percent of gross income for month.
Housing plus debt costs are 41 percent of gross income for month.

Taxes and insurance
Moreover, lenders include the cost of taxes and insurance when calculating how much house you can afford:

• Real estate taxes: Because property taxes are part of your mortgage payment for month, to get an estimate of what yours would be is important. For the rates that apply in the area you want to buy you should ask your real estate agent or tax office.

• Homeowners insurance: To obtain a mortgage you must insure your property. You can get an estimate of insurance costs from an insurance company or insurance agent. Be sure to inquire about special requirements for hazard insurance, such as mandatory coverage for floods, wind (in coastal areas) or earthquakes. You also will have to obtain mortgage insurance or take out a second loan, called a piggyback loan, to bring the first mortgage down to 80 percent of the purchase price, in case you put down less than 20 percent of your home’s value. These alternatives will raise your monthly payment.